Question

Entity W sells 50 pairs of shoes on 1 February 20X5 for $70 a pair.

The contract with customers allows the shoes to be returned for a full refund if returned within 30 days.
Past experience indicates that there is a 60% chance that 2 pairs would be returned, 30% chance that no pairs would be returned and 10% chance that 5 pairs would be returned.
What is the revenue that should be recognised on 1 February 20X5 if the expected value method is used?
A. $2,016
B. $3,360
C. $3,381
D. $3,455

Answer 1

To calculate the recognized revenue on 1 February 20X5 using the expected value method, the expected number of shoe returns is determined based on the given probabilities. After calculating an expected return of 1.7 pairs, the recognizable revenue is computed to be $3381 by subtracting the revenue loss from the total initial revenue (C).

Step-by-step explanation:

To calculate the revenue recognition on 1 February 20X5 using the expected value method, we need to take into account the probabilities and the number of shoes that could be returned. The expected number of returns can be calculated as follows:

• 60% chance that 2 pairs will be returned
• 30% chance that no pairs will be returned
• 10% chance that 5 pairs will be returned

Using the expected value method:

Expected returns = (0.60 × 2) + (0.30 × 0) + (0.10 × 5) = 1.7 pairs

The revenue loss from returns = 1.7 pairs × $70/pair = $119

Total initial revenue from selling 50 pairs = 50 × $70 = $3500

Recognizable revenue = Total initial revenue – Revenue loss from returns

Recognizable revenue = $3500 – $119 = $3381

Therefore, the recognized revenue on 1 February 20X5 would be $3381.